19/05/2016 - 15:22

Going backwards into an uncertain economic future

19/05/2016 - 15:22

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ANALYSIS: The recent state budget did little to convince voters the Barnett government is on the right track ahead of the 2017 election.

GROWTH: Tourism in the state’s South West is one area with economic potential, with interstate and international visitors able to access the region more easily after 2018 when the Busselton airport expansion is completed.

ANALYSIS: The recent state budget did little to convince voters the Barnett government is on the right track ahead of the 2017 election.

Government budgets are always political documents with a smattering of economics, but even with this month’s state budget the last before next year’s poll it is the economics that really matter, because it shows Western Australia has officially gone into reverse.

For business, the flip from near double-digit annual economic expansion a few years ago when WA was riding on the back of a Chinese dragon, to minus 0.25 per cent this financial year, and minus 0.5 per cent next year, will be a painful experience.

However, those are the forecasts for gross state product (GSP) in the WA government’s budget after removing the effects of inflation; and they are the principal reason why business will have to hunt harder than ever for assets and opportunities that can grow at a time of economic contraction.

The official argument from people such as the treasurer, Mike Nahan, is that WA continues to grow, with GSP forecast to increase by 1 per cent in the current financial year followed by a 1.25 per cent increase in GSP next year.

Both of those numbers are less than the forecast inflation rate of 1.25 per cent this year and 1.75 per cent next year, negating any growth and effectively meaning that the state is shrinking in real economic terms, no matter what spin the government puts on the situation.

Finding growth opportunities in a negative economic climate has never been more important, and while there aren’t many they do exist. However, they also require business to adapt by cutting exposure to yesterday’s growth industries and expanding exposure to industries with growth potential.

A starting point, as has been the case in prior periods of contraction, is the state’s gold industry, which is expanding rapidly thanks to a stronger $US gold price and the lower value of the $A, a point explored by Business News in a March 30 report headed ‘Gold gets its mojo back’.

That story was written at a time when the gold price had risen to $A1,640 an ounce, more than enough to ensure that every mine in the state was profitable.

Since then the gold price has added a further $A100/oz to reached $A1,749/oz, prompting a keenly awaited exploration response that has escaped official data but can be seen in the research of leading investment banks such as UBS.

In its latest look at the Australian gold sector, UBS discovered that spending on exploration by the stocks it researches had risen from $115 million in 2015 to a forecast $180 million this year, with the lion’s share of the spending in WA – Australia’s major gold-producing state.

Students of economic history have seen this trend before, with gold saving WA from penury in the 1890s and 1930s; and while the state’s economy is not as unwell as during those periods of depression, it is sick.

Other industries to offer greater potential than the anaemic budget forecasts include:
• agriculture and its associate service industries, which, subject to rain and other weather conditions, is making a solid recovery after years of playing second fiddle to iron ore mining and petroleum production (gas and oil);
• tourism, which is benefiting from the sliding value of the Australian dollar, a trend that works in two ways – limiting overseas holidays by locals and encouraging international visitors;
• education, which is also benefiting from the lower dollar and the hunt by wealthy Asian students for a Western education in English; and
• a handful of speciality minerals in demand from technology developments, with lithium and tantalum at the top of that list followed by potash, which is more of an agricultural product given its use as a fertiliser to boost crop yields.

Not growing are three industries that have dominated WA business for the past two decades – iron ore, nickel and gas – all hammered by price collapses and a tough outlook thanks to global oversupply.

The importance of contraction replacing growth changes almost everything in WA; and that could include changes at the top in government as pressure mounts on the premier, Colin Barnett, and the conservative government he currently heads at the state election, scheduled for early next year.

What’s forced the government into a potentially losing position at a political level is the change of economic fortune that was exposed in the latest budget, a document that laid bare the folly of believing that China’s demand for WA’s minerals and gas would keep prices higher for longer.

A series of graphs from Budget Paper No 3 tell the story of WA’s economy, particularly regarding economic growth and consumption, which has fallen off a cliff, and the collapse in business investment.

Everything in the graphs demonstrates why government debt has exploded, thanks to a belief that tax and royalty revenue would continue to rise and enable the government to service expanded borrowing.

Revenue is not rising and that’s why plum government assets are for sale and unemployment is going up (see graph).

It is also why any sensible businessperson is looking for sectors of the economy that can survive and grow in difficult times, as they adjust to the fact that the old economic formula has run its course and a new approach is required.

This is also one of the reasons Mr Barnett might face a leadership challenge later this year.

Just how bad the outlook is at a government level can be measured in a number of ways. The GSP growth forecast after inflation is one. The state’s soaring debt level is another, as is an equally alarming rise in the annual budget deficit.

Debt is forecast to reach $33.8 billion next financial year, continuing to rise for the next four years to $40.2 billion, or more than $16,000 for every person living in WA.

The budget deficit, which flows into the debt, is forecast to be $3.9 billion next financial year with no hope of a return to surplus before the 2019-20 financial year, when the forecast is for a $1.1 billion surplus; and that four-year forecast must be treated as a guess with a very wide margin for error.

Business can learn a lot from the budget, with the most important lesson being to avoid, if possible, doing business with any government agency. The simple reason for this is that you will be dealing with an organisation under financial pressure, which means it will be slow in paying its bills, and will probably ask for extended credit terms.

Perhaps worse than the situation in which the government finds itself today is the outlook and an assumption that the problems can be partially repaired by asset sales, such as disposing of the transmission and distribution assets of Western Power and Horizon Power.

In theory, the power assets could generate proceeds of up to $16 billion, but selling them will require a political decision and there is no guarantee that either the current government or its successor will be able to sell politically sensitive state-owned assets.

Because the political future has turned cloudy, partly as a result of the poor economic outlook, it would be wise for business to assume that big assets are likely to remain unsold, that the budget deficit will widen beyond that forecast, and that state debt will continue to grow.

At some point, and this is the key consideration, the financial problems building inside the WA government will reach a crisis point that will call for a sharp reduction in spending and an equally sharp increase in state taxes and charges.

Either the state government will make the changes or they will be forced by international ratings agencies that make deeper cuts to WA’s credit rating, which will force even higher interest rates on state debt.

Cold comfort it might be but the WA government is not alone in facing an uncertain financial future, and the best reaction of business would be to minimise its dealings with government, maximise its export earnings (if possible), and identify industries likely to grow in a cold, low-growth, economic climate.

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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